During a merge, the deactivation of the subordinate record is an internal operation, which I expect is why it does not cause your plugin to fire.
I expect you'll also have to register your plugin on the Merge message. You'll probably also have to change your code a little to read the primary key of the record to deactivate from the SubordinateId InputParameter
Microsoft CRM MVP - http://mscrmuk.blogspot.com/ http://www.excitation.co.uk